Inflation, fiscal deficit cap ratings upgrade: Moody’s

Growth likely to remain at 5% this year and rise further in 2016

Global credit rating agency Moody’s on Wednesday said India’s economic recovery manifested by Q1 GDP data showing a growth of 5.7 per cent has underpinned the stable (Baa3) outlook but warned inflation remained high, weighing down an otherwise promising economy.

Amid currency volatility, declining investment and poor market sentiment, India’s GDP had slipped to sub 5 per cent levels over the last two years. Reversal of this trend in April-June quarter this financial year is welcome and the country is poised for acceleration in GDP growth based on expected policy reforms and robust investor sentiment.

According to the HSBC PMI, India’s services sector activity and new business flows expanded only at a modest pace in August. This follows a temporary post-election boost in activity. Business confidence deteriorated further, which calls for a pick-up in the reform momentum.

Faster reforms are also needed to sustain growth momentum and counter the coming drag on the economy from weak monsoons, fiscal consolidation and tight monetary policy. The good news is that inflation is cooling, which should bring the RBI closer to its January 2015 inflation target of 8 per cent. Moody’s said growth will still likely to remain above 5 per cent this year and rise further in fiscal 2016. A decline in the fiscal deficit based on revenue buoyancy alone would be credit neutral at best, as the fiscal position would remain vulnerable to future cyclical downturns and external shocks.

The government has projected to bring down fiscal deficit to 4.1 per cent of GDP this financial year. This would help in reining-in inflation, which still remained high, retail inflation remained close to eight per cent even through there are some signs of slowing down.

Recurrent inflationary pressures have constrained India’s sovereign rating as they keep domestic capital costs high, erode domestic purchasing power as well as savings and lower international competitiveness, Moody’s said.

The central government’s efforts to implement effective supply-side policies may be complicated by the intricate nature of current agricultural market practices and the fact that agriculture is a state-level subject in India’s federal system, Moody’s said, adding, that if the gap between food demand and supply does not narrow, food costs will keep mounting. “We also expect a recovery in growth to have a positive effect on India’s balance of payments and foreign reserves, via renewed investor appetite and capital inflows. Rising reserves are unlikely to provide uplift to India’s credit profile, as long as capital flows are skewed towards increasing portfolio investment and higher external bond and bank borrowing. In such a scenario, India will remain vulnerable to domestic or global shocks that could lead to a cessation or reversal of these flows. Hence achieving greater competitiveness for manufactured goods through lower inflation or infrastructure development would lower India’s merchandise trade deficit, benefiting the sovereign credit profile as well as rise in FDI inflow.

“Nonetheless, we forecast India’s fiscal, inflation and infrastructure metrics to remain weaker than the median for similarly rated peers. While stronger growth in this large and diverse economy will help to counterbalance these credit challenges, they limit further upward momentum in the sovereign rating,” it said.